Aphria (APHA) and Tilray (TLRY) made headlines in December when they announced they would be joining forces. Mega-mergers like this aren't common in the cannabis industry, especially not ones that fuse a pair of its bigger players.
But investors aren't too excited about this deal -- Aphria's stock price has slid in the weeks since the announcement, from more than $8 a share to under $7. The Ontario-based pot stock is still up around 35% year to date, however, wildly outperforming the Horizons Marijuana Life Sciences ETF, which is down 3%.
Has this month's slide opened up an opportunity to buy Aphria shares at a discount, or will the merger with Tilray drag the stock even further down?
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Why would merging with Tilray have a negative effect on Aphria?
Following Aphria's "reverse acquisition" of Tilray in an all-stock transaction, it will become the largest marijuana company in the world on a pro forma revenue basis, expected to generate $685 million in sales annually. Yet despite the potentially dominant position that could give Aphria in its industry, the market has punished its shares. Tilray, meanwhile, traded higher, which is understandable given the premium its shareholders will be paid in the deal.
Part of the problem, though, is that Aphria has generally been the more stable cannabis company. Investors are likely concerned that the combination could end up doing it more harm than good.
Tilray, for instance, reported a net loss of $268.1 million for the first three quarters of 2020. That's more than double the $102 million loss it incurred over the same period of 2019, even though its sales were up 28% year over year to $153.9 million. By comparison, when Aphria released the year-end results for its fiscal 2020 (which ended May 31), its net loss was just 84.6 million Canadian dollars for a full 12 months.
It's easy to understand why shareholders in a company that has achieved sixth straight quarters of adjusted positive EBITDA may not be all that excited about the prospects of it linking up with a business that's hoping to finally hit breakeven (or better) by next quarter.
Profitability is a big concern for cannabis investors because the lack of it can reflect poor cash flow and lead businesses to issue more shares, diluting earlier shareholders.
Does this mean Aphria is a bad buy?
Although Aphria's stock price is down since the merger announcement, that doesn't mean the company's shares will remain on a negative trajectory over the long term.
Acquisitions and mergers often have a negative impact on a buyer's stock over the short term even if in the long run, the deal produces significant returns. So the short answer is no, that Aphria isn't necessarily a bad buy because of the merger with Tilray, nor is the recent decline necessarily a sign of bad things to come. The companies' different elements will combine to produce a more diverse business that may be better able to deliver long-term growth.
Tilray is a big player in hemp; that segment of its business generated $61.5 million in sales over the first nine months of 2020. That was 40% of its top line and more revenue than the $58.5 million it brought in from selling adult-use cannabis. The hemp market offers a path for Aphria to expand its presence in the U.S., where hemp-derived cannabidiol products are legal federally and can cross the border from Canada.
That dovetails well with Aphria's current strategy of pursuing opportunities in the U.S. market. On Nov. 30, the company announced it had closed a $300 million cash-and-stock deal to buy Sweetwater Brewing Company. Acquiring the craft brewer helps position Aphria for growth in the cannabis beverage segment in the U.S. once it's legal to sell such products. It could also unlock opportunities on a global scale. Research company Prohibition Partners estimates that the market for cannabis-infused drinks worldwide could top $5.8 billion in 2024, more than three times the $1.8 billion it is worth today.
Should you buy shares of Aphria today?
Overall, there are more positives than there are negatives from this merger deal, especially over the long term. Consolidation in the industry is inevitable and by combining resources, the two companies should be better off -- but that isn't a guarantee. There will likely be short-term pain, including layoffs and other cost-cutting measures as they consolidate. How efficient Aphria is in fine-tuning the combined operations will be key in determining how strong the bottom line will be after all the dust settles.
Still, while the recent drop in Aphria's stock has made it a more attractive buy, in my view, it's a bit too risky an investment to make right now. Over the long term, it could generate some excellent gains, but things will likely get worse for it before they get better. Investors may be better off waiting for further dips in the stock price before buying Aphria stock.
